Housing Tax Bubble

Rising property values fomented tax reform in South Carolina, but
restrictions in the new law may haunt the state.

John E. Petersen was GOVERNING's Public Finance columnist. He was a Professor of Public Policy and Finance at the George Mason School of Public Policy.

South Carolina runs on a shoestring. It always has. But the state's long-standing embrace of financial tightness leaves most of the financial heavy lifting to local governments. That's why, even though talking about taxes can be suicidal in this bastion of conservatism, the state has rumbled for the past two years with tax-reform plans. Not that the state itself needed more money but rather local property taxes were too high, especially levies for public schools.

The complicated tax-reform bill that passed in June tries to solve that problem. It replaces local residential property taxes for school purposes with an increase in the state sales tax. But in the reform process, the state adopted restrictions that may very well come back to haunt it.

Almost always, the immediate impetus to alter property taxes is rising home prices. And in South Carolina, housing prices have been climbing as they have in much of the country. From 2002 to 2005, South Carolina median existing-home sale prices increased 6 percent a year statewide--although that was less than the average 7 percent annual increases in the South or 11 percent a year nationally. But the state's prospering coastal region has seen sharper increases and, accordingly, rising tax bills.

To outsiders, South Carolina is not a high-tax state. It ranks below the median in regard to tax burdens, including the property tax. But, when it comes to the public school share of the property tax, various exemptions have shifted its burden onto higher-priced and non- residential properties. This constriction of the base has meant even higher rates to derive needed revenues.

Discussing the property tax in any state is akin to rummaging in its fiscal attic. There are a lot of odd pieces and curiosities lying around, and so it is in South Carolina, which has five-year reassessment cycles, a collage of very low assessment ratios and numerous special treatments. The upshot is that the nominal assessed values (4 to 10 percent of market values) are tiny, with the result that tax rates are very high. Worse yet, a host of local government jurisdictions--cities, counties, school districts, special taxing districts--all climb aboard the property-tax bill, a source of serious confusion. Sundry exemptions mean that almost half the taxpayers (owner-occupied homes valued at less than $100,000) don't pay school property taxes. In other words, the property-tax base is drawn and quartered to fit the political pressures of years long gone by.

Rather than taking the broom to the antiquated property-tax structure, the June tax reform consists of removing local schools from local property-tax bills and making them a state responsibility. This, in turn, is to be paid for by a 1-cent increase in the sales tax. Sounds great, but the changes in the South Carolina tax laws mean substantial redistribution impacts on tax burdens.

In Charleston, for instance, property-tax reform saves the owner of a $1 million home $3,300 in taxes, whereas the owner of a median family home assessed at $178,500 saves $358. Those with homes less than the state's median value and renters will save next to nothing. On the flip side, consumers will pay higher sales taxes, and since the poor consume more of their incomes, they will see their taxes rise. The sales tax on groceries was lowered by 2 cents, but that applies to filet mignon as well as hot dogs.

A worrisome flaw in reform is the "Prop 13" approach of constitutionally defining the market value of properties. The reform entails a provision that says that assessed values of owner-occupied properties (unless sold or improved) cannot increase more than 15 percent in five years. That means an average annual rate increase in value of no more than 2.8 percent a year. So much for true market values. Disengaging from actual market values means that some people benefit more than others by legislative fiat. The impact, likely intended, is to favor those who now own homes over newcomers, a discriminatory impact that will grow over the years.

Another concern is placing the additional costs of public education on the back of a state tax system that is already limited. California, Michigan and Oregon have already trod down this path, placing limits on the property taxes in the process of moving local education finance to the state level. The burden on state budgets can become enormous.

South Carolina, rather than reassessing its overall tax system, has concocted more flotsam and jetsam to clutter its fiscal attic. By amending its constitution in the process, it will make future housecleanings that much harder. So, which of the other 49 states is ready to throw stones.